To understand why a penalty is levied, you’ll need to have a fair idea about the Settlement cycle and the concept of Margin reporting in India.

The settlement cycle in India for Equities is T+2 and for F&O is T+1. What this means is that when you sell Equities and receive money as sale proceeds, such sale proceeds can be withdrawn only on T+2 day. So assume you sold stocks worth Rs.1,25,000 on Monday, you would be able to withdraw these funds only on Wednesday (Monday - T-Day, Tuesday - T+1 Day, Wednesday - T+2 Day).Similarly when you sell F&O positions you would be able to withdraw these funds on T+1 day only.

The important thing to note here is that whenever you sell an Equity position or an F&O/CDS position, only on the respective settlement day the funds become ‘YOUR’ funds. From the time you sell till the time its settled, they would be considered encumbered funds.

Margin Reporting: Whenever you take a position in the F&O/CDS Segment, the Exchange requires all brokers to report the funds available for such positions taken by client on a client to client level. So if you buy Nifty Options for a lac, the Exchange would ask your broker of the availability of funds in your account and report the same to the Exchange. While reporting the availability of funds, your broker is required to consider only ‘free’ or ‘unencumbered’ balance. Any short reporting will attract penalty. So if your broker allows you to buy options worth Rs.1, 00,000 with only Rs.60, 000 in your account, the shortage in your account would be Rs.40, 000 on which a penalty is levied.

Specifically to the question you’ve asked, when you buy options on Monday and sell them on Tuesday, the credit realized from sale of these options would be realized only on Wednesday (T+1), hence while your broker is reporting margins to the Exchange for fresh buys you’d have made on Wednesday, he would NOT consider the credit realized from sale of options on Tuesday resulting in Short reporting and subsequent levy of penalty.

For e.g.: Let’s assume you transferred Rs.90,000 to your trading account and bought Options worth Rs.90,000 on Monday, sold them for a value of Rs.1,10,000 on Tuesday and bought fresh options for Rs.1,00,000 on Tuesday.

Now when your broker is reporting margins, he would report sufficient margins for your purchase on Monday (Rs.90, 000) because you had cash in your account. However while reporting margins for Tuesday (you’ve made purchases worth 1, 00,000 from the sale proceeds of Rs.1, 10,000) your broker would not report any margin because the sale proceeds would be realized only on Wednesday. So technically you have no free balance in your account on Tuesday resulting in short reporting and a penalty being charged on your account.

Venu does this happen always, cause we’ve never seen such a scenario before. And if this is the exchanges process then why do brokers let the client take the position in first place and even if they do, they can square it off as intraday trade rather than client incurring the penalty

Hi Rakesh,
This is the way brokers are expected to report margins. If a broker reports short margin the penalty is either 0.5% or 1% of the short reported margin, however if the broker reports wrong margins, penalty is 100%. As to why the broker lets you take positions, is because as a broker the funds are kind of assured to come. There is no risk a broker has to take to allow the client to take positions. It would be ‘business unfriendly’ for them to not allow the client to take the position. Why does a client take position despite knowing that a penalty will be levied? If he thinks by taking the position he stands to make much more than the 1% penalty imposed, he would rather take the position, wouldn’t he?
Another point to note is that the concept of levying penalty for short margin has been enforced from 2010 onwards. So, brokers are used to letting clients take positions and a change of policy wouldn’t be favorable for their businesses.

But Venu do the traders actually know this. Cause such penalties are difficult to trace as its not available clearly on the site of SEBI / NSE.
So do the brokers actually send out any warning or alerts to clients when such a position is taken. Because I don’t think its easy for trader to figure this out on his own. Very few people apart from you would have known this?

Its actually difficult on part of a trader to know all the rules pertaining in the markets. The broker may also emphasize on such points making it easier for the client to know.
Yes, some trading terminals do provide such alerts that the client may run a risk of being charged a penalty when he is utilizing encumbered funds. Geojit is one brokerage house that I know of who gives such alerts.

I buy and sell options even on the same day or later any days and I am taking positions immediately by that sold amount. I have never seen such penalties so far… I am confused with your answer… what am i missing here to understand?

Zerodha has charged me penalty charges of 1500 rs but I don’t see any reason for it, also along with margin there was free cash available all the time.
And how do they calculate this, since i had positive freecash with me all the time, is this fair also.

Also, in your explanation above, in the example, when the trader is buying fresh options using proceeds of sale on day 2 … The sale proceeds are available on T+1 (wednesday / Day3) but shouldnt the same be applicable to the second purchase transaction as well?

For the purchase transaction on day 2, shouldnt the funds be required in the account on T+1 only and not T (as per exchange rules)?

What’s confusing here dear!
When you have to deposit money… you need to do it immediately.
When you are entitled to receive money…wait for 1 or 2 days.

For eg. You buy SBI shares or FnO - you need to pay for the cash/margin immediately, on the spot, at once. Money deducted from your account. Now wait for shares to be delivered on t+2.

Now you sell shares of SBI already in your demat. Now you must think that if the buyer is getting that shares from xchange only on t+2 then they will remain with me till then. NOOOO. You sell. The shares are immediately deducted from your demat.
Now both you the seller wait for your money & he the buyer wait for his shares …till t+2
But actually broker/xchange has deducted both the shares from you and the money from the buyer immediately.

AFAK,
In intraday - you have 5k. you buy opt of 3k and sell for 4k. So you realised profit of 1k. Zerodha shows that 1k as used margin for whole day. So you still got only earlier 5k to trade and not 6k. you again buy 3k of opt as CF. No penalty.

But yes, if you buy 6k - you over consumed your margin by 1k. hence penalty.